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The Nobel Series: Pacemaker of industrial organisation

Through his extensive contribution in applied research, George Stigler institutionalised information in neoclassical framework and integrated regulation within the standard economic theory to expose its ills

The Nobel Series: Pacemaker of industrial organisation
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The Nobel Prize in Economics in 1982 was awarded to George Stigler for his study of market processes, industrial organization and various aspects of economics of regulation. As the Nobel website says, Stigler got the prize for: his seminal studies of industrial structures, functioning of markets and causes and effects of public regulation.

Stigler got his undergraduate degree in 1931 from the University of Washington, after which he obtained an MBA degree from Northwestern University in 1932. He moved to the University of Chicago thereafter on a scholarship and got his PhD from here in 1938. While at Chicago, he was influenced greatly by his dissertation supervisor Frank Knight and Jacob Viner. Milton Friedman was his fellow student at Chicago. He taught at Iowa State College during 1936-38, where TW Schultz (Nobel Prize winner in 1979) was the department chairman. Two years later, he went to the University of Minnesota from where he also worked as a member of the Statistical Research Group at Columbia University during the War. After the War, he returned to Minnesota, from where he moved to Brown University, and then to Columbia University from 1947 until 1958. In 1958, he came to Chicago where he remained till he retired.

While Stigler is best known for his economic theory of regulation and economics of information, he was awarded the Nobel Prize for his work on industrial organization and its interplay with regulation. In this article, we will discuss the main works of Stigler and their relevance to public policy.

Main works of Stigler

From his early years, Stigler showed an extraordinary variation in the range of his work. At the University of Minnesota, his work included a paper on production and distribution, a critical review of a statistical method, and a theoretical paper on duopoly. He also worked on price theory from his early days and remained involved in multiple facets of price theory till the end of his career. In 1946, he published his well-known book, 'The Theory of Price', which is still used as a textbook in economics across the world.

However, much of Stigler's main works came after he moved to the University of Chicago in 1958. These included the economics of information and the theory of regulation, which led to his work on industrial organization.

One of Stigler's most well-known works and most-cited paper, 'The economics of information' was published in 1961. This discussed the costs and benefits to both producers and consumers of supplying and obtaining information about commodities. According to Friedman, Stigler "essentially created a new area of study for economists." Stigler stressed the importance of information "One should hardly have to tell academicians that information is a valuable resource; knowledge is power. And yet, it occupies a slum-dwelling in the town of economics." Stigler's work was a departure from the traditional neoclassical framework where every commodity is sold for the same price everywhere (if you rule out transport costs). However, one sees wide variations in price, which according to Stigler, are because of search and information costs. The amount of information any economic agent gathers depends on the cost and benefits of such an exercise. Stigler, therefore, integrated these issues of asymmetric information into the neoclassical framework. They are no longer unnecessary market imperfections that can give rise to government intervention. Stigler extended his information theory to other areas such as market equilibrium in an oligopoly and the job market (cost-benefit of searching for prospective employers). In his article 'Information in the Labour Market', published in 1962, Stigler suggested that the unemployed are constantly looking for better-paying jobs and are therefore are also information seekers. His theory is now called the theory of search unemployment.

Stigler's other major contribution was his theory of regulation. Much before he outlined his theory of regulation in a paper in 1961, Stigler studied the effects of regulation in the 1940s concerning rent control and minimum-wage legislation. He found that regulation often had unintended side effects and sometimes even effects that could not be observed. In later studies of regulatory legislation, Stigler has emphasized its causes rather than its effects. He found that some regulations protected the producers rather than the general public. He went on to show that legislation may be an outcome of the optimizing behaviour of economic agents. To that extent, regulatory laws can't be assumed to be exogenous to the model since they were being determined within the economic system. All this work culminated in his celebrated paper 'The theory of economic regulation', published in 1961, in which he argued that standard economic theory can be applied to determine when and how regulation will take place. He also found regulatory agencies were liable to be "captured" by the very industries they were supposed to regulate. They tended to protect the interests of the regulated industry to the disadvantage of the consumer.

Stigler's work in the economics of information and his theory of regulation took him to his other main work, namely, his study of economic and political institutions and industrial organization. Among his first efforts in this area, he confirmed a correlation between a given industry's profit margin and the degree to which that industry is concentrated in a few large firms. In addition, he co-authored a paper with Claire Friedland of the University of Chicago, on the effects of regulation on rates and profits in electric utilities. The paper showed that nonregulated electric utilities of the 1930s tended to behave similarly to their regulated counterparts. Stigler's articles on industrial organization are reprinted in 'The Organization of Industry (1968)', which discusses monopoly and antitrust policy. His papers on antitrust policy and oligopoly bought out the issues of regulation and information that he had been dealing with.

Stigler continued to be active in other areas of economics as well. During the post-World War II housing shortage, for example, he wrote a controversial pamphlet titled 'Roofs or ceilings?' with Milton Friedman, University of Chicago. The pamphlet used statistics to argue that rent controls had the inevitable effect of distorting the rental market, bringing about severe shortages of apartments. He also published numerous papers on a variety of subjects, including monopolies, utility theory, the study of how the consumer's use of a product affects how that product is marketed, the limits on the division of labour in a given market etc. Another example of Stigler's empirical obsessiveness was displayed in a paper titled 'De gustibus non estdisputandum', co-authored in 1977 with Gary S Becker of the University of Chicago. The title translates as 'There's no accounting for taste'. In this paper, Stigler rejected the argument that those preferences that are driven by personal tastes can't be explained by economic theory. Instead, he proposed that economic logic and analysis be applied for such explanations. He asserts that it is not taste that change, but levels of economic information. Stigler continued his combination of theory and empirical thrust and applied it to various areas such as the economics of crime and elections, apart from the theory of regulation and information discussed above. Stigler also looked at how differences in rates of return are equalized through movements of capital and from low-yield to high-yield firms, even if the process might take as long as a decade.

As the Nobel website says:

Stigler's achievements establish him as a leader in applied research on markets and industrial structure – a field often known as industrial organization. Through particular features of his research, Stigler is also recognized as the founder of "economics of information" and "economics of regulation", and one of the pioneers of research in the intersection of economics and law.

Stigler's work and public policy

Stigler deserves a great deal of credit for getting economists to look at data and evidence and using this to formulate policy. As seen above, Stigler's work led to a lot of research in areas of information, regulation and industrial organization which are still being used as inputs in policy formulation.

It may be recalled that in one of his earliest applications of regulation to public policy, he had analysed the electricity sector. In his paper, of 1962 'What Can Regulators Regulate? The Case of Electricity', he found that regulation had little effect on electricity prices. Similarly, he found little impact of the Securities and Exchange Commission in the US. As noted above, his most well-known work published in 1971, 'The Theory of Economic Regulation', has been used to illustrate the capture of regulatory agencies by the producers. This line of thinking also alerted governments the world over to the reality of such capture and led to firewalls between regulatory agencies and the producers they seek to regulate.

As noted above, in his article 'The Economics of Information', he had underlined the importance of search costs and how to reduce these — by localization, advertising, specialized dealers, firms that collect and sell information, and so on. His work on information had a widespread impact, beyond advertising. As the Swedish Academy says, "phenomena such as price rigidity, variations in delivery periods, queuing and unutilized resources, which are essential features of market processes, can be afforded a strict explanation within the framework of basic economic assumptions." The other applications of Stigler's application were found in his own work on rent controls and minimum wage legislation in the 1940s.

Conclusion

Stigler's contribution in the areas of regulation, information and industrial organization have found continued relevance even today in various policy areas. His work, which combined theory, backed up with strong empirical analysis has helped governments design not only regulations but also the structure of regulatory agencies. His scepticism about the effects of regulation were well known since he thought that regulatory agencies could be easily captured by those they were meant to regulate. In his presidential address to the American Economic Association in 1964, on "The Economist and the State", he had sent out a clear message to economists by saying that they should first analyse

the effects of government intervention before saying that it is good or bad or the public sector should be preferred over the private sector. He also emphasized the use of quantitative methods to do this analysis.

Stigler's treatment of regulation as a 'good' supplied by political parties and demanded by the producers was novel. Of course, the producers bid for particular regulation and the highest bidder was likely to be the industry that was regulated, leading to capture of the agency itself. As the Swedish Academy points out, that "legislation is no longer an 'exogenous' force which affects the economy from the outside, but an 'endogenous' part of the economic system itself." This finding has wider implications for political activity. That is why the Swedish Academy was also a little cautious about the causes and effects of regulation, stating that "it is still too early to assess its ultimate scope". However, Stigler put us on the right track and forced us into thinking about the ill effects of regulation and how these should be addressed. His contributions in information and industrial organization, along with regulation continue to guide policymakers across the world.

Views expressed are personal

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